US Bond Research Articles

Spillover impact of the US unconventional monetary policy and uncertainties on stock-bond correlations

This paper investigates the spillover impact of US unconventional monetary policy and uncertainty factors on the time-varying co-movements between the US stock market and 14 advanced countries? bond markets, as based on monthly data from January 2002, to October 2015, and utilising the conditional nonlinear quantile regression approach. The empirical results reveal that US unconventional monetary policy has an asymmetric positive effect on stockbond market co-movements, with a nonlinear effect in France and Denmark and a strong effect in the UK and Finland. Further, US bond market uncertainty has heterogeneous effects on stock-bond market co-movements, with a nonlinear effect in France and Denmark and a strong effect in Finland and Sweden. In addition, default risk spread positively influences stock-bond market co-movements across most countries for all quantiles. In contrast, stock-bond market comovements negatively and symmetrically respond to the US stock market uncertainty in most countries. Finally, stock-bond co-movements exhibit mixed responses to US economic policy uncertainty across countries. Our results have valuable implications for international investors who allocate capital across developed countries? stock and bond markets. Our findings provide important information for financial communities with regard to diversification and hedging.

The FOMC announcement returns on long-term US and German bond futures

• We examine the impact of FOMC announcements on long-term US and German government bond futures. • Using transaction-level data during the post–financial crisis period, we observe a sizable post-announcement drift in government bond markets. • A trading strategy yields up to four times the Sharpe ratio of buy-and-hold investment. • The post-FOMC drift coincides with more informative order flows in the post-announcement period. • Post-FOMC announcement drift in the government bond futures persists for 15 days. We examine the impact of monetary policy announcements by the Federal Open Market Committee (FOMC) on long-term US and German bond futures. Using transaction-level data during the post-financial crisis period, we observe a sizable post-announcement drift in government bond markets. A trading strategy of investing in the market after expansionary shocks and shorting the market following contractionary surprises yields up to four times the Sharpe ratio of buy-and-hold investment. The post-FOMC announcement drift coincides with more informative order flows in the post-announcement period, and it persists for 15 days. Moreover, our study shows an absence of pre-FOMC announcement drift. Our findings shed some light on how the bond markets react to public news arrival.

Asymmetric Impacts of Inflation on the US Bond Rates and FED’s Pre-Emptive Policy

Abstract This study investigates the asymmetric impacts of changes in inflation rates on the US bond rates. This investigation is constructed on the Fisher Equation. To this end, the nonlinear ARDL model is applied. Empirical findings indicate that only the decreases (π− t ) in inflation rates affect bond rates. This asymmetric impact therefore shapes the FED’s monetary policy in terms of determining the bond rates at lower cost. When the inflation rate rises, the FED will know (in advance) that they do not need to increase the bond rates. This reminds us the FED’s former pre-emptive strike policy against inflation.

Where lies the silver lining when uncertainty hang dark clouds over the global financial markets?

This study offers ray of hope for financial investors in five classes of assets [precious metals, fiat & virtual currencies, commodities, and long-term government bonds] that can provide protection against uncertainty risks captured in three well-known uncertainty indicators. The motivation for the study is that portfolio risk-management strategies can be enhanced by having expanded options of risk-free assets that are capable of delivering positive returns in harsh market situations. The in-depth analysis involve: (1) alternative econometric techniques and data frequencies, (2) use of country-specific economic policy uncertainty indices to complement the global index, (3) distinct analysis for the COVID-19 first wave period due to extant argument that the pandemic raise market uncertainties and our preliminary results showing co-movement among the three uncertainty indicators during the pandemic. The first set of results show all the seven assets as safe haven assets. The second set conducted for the first wave of the pandemic excludes long-term bonds & the US dollar. The study therefore recommends gold, silver, commodity futures and Bitcoin for inclusion in diversified portfolio risk-management strategies. The US dollar and bonds may not be considered.

Stocks, Bonds, Bills, and Inflation® (SBBI®): 2020 Summary Edition

This Stocks, Bonds, Bills, and Inflation® (SBBI®): 2020 Summary Edition enables investors to understand how to calculate, interpret, and use the US historical stock and bond data that the CFA Institute Research Foundation has made available to CFA Institute members. The data include the capital appreciation, income, and total returns of the major asset classes of the US economy: large-cap stocks, small-cap stocks, corporate bonds, government bonds of various maturities, and inflation. Most of the data start in 1926, and are presented in monthly, annual, decade, or longer period form. The raw data itself are mostly monthly but are not included in this summary volume. Rather, this summary volume includes illustrative data, methodology, formulae, and analysis that will help investors and analysts learn how to use market time series raw data, which is separately available.

Political sensitivity and government oversight in the US corporate bond market: evidence from federal contractors

PurposeThis paper aims to investigate the political cost hypothesis and the effects of political sensitivity-induced governance in the US bond market by using yield spreads from bonds issued by a diverse sample of US government contractors.Design/methodology/approachFixed effects regression analysis is used to test the relation between the political sensitivity of government contractor firms and their cost of debt.FindingsResults illustrated that government contractors with greater political sensitivity are associated with larger yield spreads, indicating that bondholders require a premium when firms endure the costs of increased political oversight and the threat of outside intervention, reducing the certainty of future income. However, despite the overall positive impact of political sensitivity on bond yield spreads on average, the authors found that the additional government oversight is associated with lower spreads when the firm is facing greater repayment risk.Practical implicationsDespite the benefits of winning a government contract, this paper identifies a direct financial cost of increased political sensitivity because of additional firm oversight and potential intervention. Importantly, it also finds that this governance is valued by bondholders when faced with increased risk. Firms must balance their desire for government receipts with the costs and benefits of dependence on those expenditures.Originality/valueThis paper contributes to the literature in its exploration of political sensitivity as an important determinant of the cost of debt for corporate government contractors. Specifically, the authors document a significant risk premium in bond pricing because of the joint effects of the visibility and importance of government contracts to the firm.

State-dependent fiscal multipliers with preferences over safe assets

I examine the effect of fiscal policy at the zero lower bound when households have preferences over safe assets (POSA) parameterized consistent with microeconomic evidence on intertemporal choices and the macroeconomic elasticity between US government debt supply and bond yields. POSA loosen the link between household consumption and permanent-income, and imply a wealth effect from government bonds. Therefore, the multiplier of a permanent expenditure change increases. I show that these conclusions carry over to an estimated DSGE model. POSA improves the empirical fit of the model if the dataset includes forward interest rates on top of fiscal and macroeconomic data.

Augmented factor models with applications to validating market risk factors and forecasting bond risk premia

We study factor models augmented by observed covariates that have explanatory powers on the unknown factors. In financial factor models, the unknown factors can be reasonably well explained by a few observable proxies, such as the Fama–French factors. In diffusion index forecasts, identified factors are strongly related to several directly measurable economic variables such as consumption-wealth variable, financial ratios, and term spread. With those covariates, both the factors and loadings are identifiable up to a rotation matrix even only with a finite dimension. To incorporate the explanatory power of these covariates, we propose a smoothed or projected principal component analysis (PCA): (i) regress the data onto the observed covariates, and (ii) take the principal components of the fitted data to estimate the loadings and factors. This allows us to more accurately estimate the percentage of both explained and unexplained components in factors and thus to assess the explanatory power of covariates. We show that both the estimated factors and loadings can be estimated with improved rates of convergence compared to the benchmark method. The degree of improvement depends on the strength of the signals, representing the explanatory power of the covariates on the factors. The proposed estimator is robust to possibly heavy-tailed distributions. We apply the model to forecast US bond risk premia, and find that the observed macroeconomic characteristics contain strong explanatory powers of the factors. The gain of forecast is more substantial when the characteristics are incorporated to estimate the common factors than directly used for forecasts.

Flight-to-quality in the stock–bond return relation: a regime-switching copula approach

This paper examines the existence, intensity and international dependence of flight-to-quality from stocks to government bonds. To this end, we develop a two-state regime-switching bivariate copula model and apply it to the domestic and cross-country stock–bond return pairs of six developed countries (France, Germany, Japan, Switzerland, the UK and the US) over the period 1999–2019. We find that US and UK government bonds have played a primary role of safe-haven assets during stock market downturns. The remaining government bond markets show the evidence of flight-to-quality, but its intensity is relatively weak. Further, we find that although flight-to-quality tends to occur simultaneously in multiple countries, the frequency of the joint occurrence varies across government bond markets.

Dynamic connectedness and portfolio strategies: Energy and metal markets

In this paper, we investigate the volatility spillover effect among the global commodity futures (including both energy and metal futures; global stock markets (covering both Developed and Emerging Markets); the US bond market and the US Dollar index by employing the dynamic connectedness approach of (Diebold and Yilmaz, 2012, 2014) based on the time-varying parameter vector autoregressive (TVP-VAR) model and using daily data for the period from January 3, 1992 to December 27, 2019. Our results indicate a moderate connectedness among the volatilities changing over time and approaching its peak level during 2007/08 global financial crises. In addition, we determine the optimal hedge ratios and portfolio weights for the commodity investors and portfolio managers. Our results indicate that for the equity market volatility investors, the highest hedging effectiveness can be reached by taking short positions in energy futures (such as natural gas), on the other hand for both the US bond and US Dollar volatility investors it can be reached by taking short positions in metal futures (such as gold).

Carry Strategies and the US Dollar Risk of US and Global Bonds

In this article, the authors investigate the ability of currency carry strategies to mitigate the US-dollar risk of US and global bond benchmark indices. Using the Fama-French and currency factors, the authors analyze the bond benchmarks and find that currency carry strategies can easily be modified to suit bond investors, portfolio managers, and allocators. A central finding of the authors is that currency carry strategies help to mitigate the currency risk of the US dollar. Specifically, broad indices (including credit and government exposure) deserve modified carry strategies to mitigate the impact on the US dollar The results show that the exposure to the equity-based profitability factor—one of the factors in the Fama-French five-factor model—is to some extent a natural hedge against the US-dollar risk of high-yield and corporate indices. Moreover, combined currency carry overlay strategies and fixed-income investments generate Probabilistic Sharpe ratios above a certain threshold level. The results suggest that investors should consider modified currency carry strategies rather than simple carry rules when managing both US and global-high yield, corporate, and government debt. The authors also provide a framework that can be used to diversify the impact of individual equity-based factors and the currency style factors on fixed-income benchmarks. TOPICS:Analysis of individual factors/risk premia, factor-based models, style investing Key Findings • Carry strategies seek to reduce the US-dollar risk and improve the risk-return profile of US domestic and global fixed-income investments. The carry strategies can easily be implemented and monitored by portfolio managers and allocators desiring to control for their US-dollar risk. • Fixed-income adjusted currency carry strategies produce better results than the simple carry strategy as measured by the Probabilistic Sharpe ratio. Investors can utilize currency carry and manage the currency risk of corporate and high-yield US and global bond benchmarks. • Currency carry strategies generate diversified factor exposure to the Fama-French factors by mitigating the US-dollar risk and increasing alternative factor exposure.

Spillover effects in oil-related CDS markets during and after the sub-prime crisis

This paper investigates the return and volatility spillover effects across oil-related credit default swaps (CDSs), the oil market, and financial market risks for the US during and after the subprime crises. The empirical analysis is based on monthly return and realized volatility data from February 2004 to April 2020. We estimate both static and dynamic generalized dynamic spillover measures based on vector autoregressive (VAR) models. Our full sample empirical findings show that the oil market is the primary source of risk transmission for all the oil-related credit default swaps, while the bond market is the highest source of risk transmission to the stock market and vice versa. We also provide evidence that the regulated monopoly US utility sector has the least role in volatility transmission. Furthermore, the bailout program conducted by the US Treasury and Federal Reserve helped stabilize the US financial market through the purchase of toxic assets after the subprime financial crisis. We find strong evidence that the federal funds rate hike cycles lessen total risk transmission throughout the US bond market. Finally, our findings assert that oil price shocks have a significant effect on the oil-related CDSs in some sub-periods via the demand and supply transmission channels.

Efectos de propagación de los mercados financieros estadounidenses en los colombianos

Este artículo cuantifica y analiza los efectos de los choques originados en los mercados estadounidenses sobre los principales mercados financieros colombianos durante el periodo de 2003 a 2015. La metodología utilizada es un modelo de vectores autorregresivos (VAR) estructural que emplea la heterocedasticidad que existe en los datos para la identificación y la estimación de los coeficientes de transmisión financiera. Se encuentra que los mercados estadounidenses generan efectos overall spillovers significativos sobre el mercado accionario colombiano. A su vez, los resultados reflejan la posición dominante del mercado de bonos estadounidenses como el motor de los efectos de desbordamiento.

Strategic Currency Hedging in Multi-Asset Portfolios

The authors provide a strategic currency hedging framework for multi-asset portfolios, helping global investors better manage foreign currency exposures by balancing hedging costs and risk. The authors focus primarily on G4 currencies—US dollar (USD), euro (EUR), pound sterling (GBP), and Japanese yen (JPY)—but also provide some insights for other G7 currencies. Starting from a single-asset-class perspective, the framework shows that developed market fixed-income instruments should generally be fully hedged back to the investor currency. US investors should fully hedge foreign exchange risk when buying European equities. Japanese equities should be left unhedged for all investors because of the Japanese yen’s value as a safe haven during market panics. Conversely, Japanese investors buying international equities should fully hedge currency risk but may find it optimal to leave some of their US bond exposures unhedged to minimize hedging costs while retaining some diversification benefits. The picture is also nuanced for European investors where the cost-benefit trade-off points to partial hedging as the optimal approach. When it comes to multi-asset investing, hedge ratio optimality also becomes a function of cross-asset correlations, which leads to interesting nuances of approach across domiciles. The authors believe their research provides global investors with useful information to calibrate strategic hedge ratios. <b>TOPICS:</b>Currency, portfolio management/multi-asset allocation <b>Key Findings</b> • We find the optimal hedge ratio dynamically derived from exploring the trade-off between hedging costs and risk minimization generally leads to superior risk adjusted returns than a static approach to currency hedging. • Our mean-variance optimization framework allows practitioners to set a flexible currency hedging policy based on their own risk preference and is applicable to single asset and multi-asset portfolios. The hedge ratio decomposition we propose sheds light on the drivers of the optimal hedge ratio and gives investors the ability to further calibrate their currency hedging policy by putting more emphasis on the driver they deem the most important. • We find developed markets fixed-income instruments should generally be fully foreign exchange (FX) hedged. US investors should fully hedge FX risk when buying European equities. Japanese equities should be left unhedged for all investors due to the Japanese yen’s risk-off characteristics. Conversely, Japanese investors buying international equities should fully hedge currency risk but may find it optimal to leave some of their US bond exposures unhedged to minimize hedging costs while retaining some diversification benefits. The picture is also nuanced for European investors where the cost-benefit trade-off points to partial hedging as the optimal approach. When it comes to multi-asset investing, hedge ratio optimality also becomes a function of cross-asset correlations, which leads to interesting trade-offs.

Interrelation and spillover effects between stocks and bonds: cross-market and cross-asset evidence

PurposeThis paper aims to examine the behaviour, both contemporaneous and causal, of stock and bond markets across four major international countries.Design/methodology/approachThe authors generate volatility and correlations using the realised volatility approach and implement a general vector autoregression approach to examine causality and spillovers.FindingsWhile results confirm that same asset-cross country return correlations and spillovers increase over time, the same in not true with variance and covariance behaviour. Volatility spillovers across countries exhibit a substantial amount of time variation; however, there is no evidence of trending in any direction. Equally, cross asset – same country correlations exhibit both negative and positive values. Further, the authors report an inverse relation between same asset – cross country return correlations and cross asset – same country return correlations, i.e. the stock return correlation across countries increases at the same time the stock and bond return correlation within each country declines. Moreover, the results show that the stock and bond return correlations exhibit commonality across countries. The results also demonstrate that stock returns lead movement in bond returns, while US stock and bond returns have predictive power other country stock and bond returns. In terms of the markets analysed, Japan exhibits a distinct nature compared with those of Germany, the UK and USA.Originality/valueThe results presented here provide a detailed characterisation of how assets interact both with each other and cross-countries and should be of interest to portfolio managers, policy-makers and those interested in modelling cross-market behaviour. Notably, the authors reveal key differences between the behaviour of stocks and bonds and across different countries.

Do Machine Learning Techniques and Dynamic Methods Help Forecast US Natural Gas Crises?

Our study combines machine learning techniques and dynamic moving window and expanding window methods to predict crises in the US natural gas market. Specifically, as machine learning models, we employ extreme gradient boosting (XGboost), support vector machines (SVMs), a logistic regression (LogR), random forests (RFs), and neural networks (NNs). The data set used to develop the model covers the period 1994 to 2019 and contains 121 explanatory variables, including those related to crude oil, stock markets, US bond and gold futures, the CBOE Volatility Index (VIX) index, and agriculture futures. To the best of our knowledge, this study is the first to combine machine learning techniques with dynamic approaches to predict US natural gas crises. To improve the model’s prediction accuracy, we applied a suite of parameter-tuning methods (e.g., grid-search) to select the best-performing hyperparameters for each model. Our empirical results demonstrated very good prediction accuracy for US natural gas crises when combining the XGboost model with the dynamic moving window method. We believe our findings will be useful to investors wanting to diversify their portfolios, as well as to policymakers wanting to take preemptive action to reduce losses.

Customer concentration types and public debt contracts

PurposeThis paper aims to examine how a firm’s customer concentration, which is the amount of sales between a supplier firm and the major customers, affects corporate bond contracts. This study also investigates how the types of customer concentration have a significant impact on bond contracts.Design/methodology/approachThe research uses the Compustat’s segment customer database and the Mergent fixed income securities database, which provides details about publicly offered US bond issues and issuers. The sample also includes the US Congressional committees’ data from the 96th to 115th congresses. To control any endogenous concerns, the author uses changes in the seniority of US senators on powerful committees and the American Recovery and Reinvestment Act of 2009 (ARRA) as exogenous shocks. For a robustness test, the author also uses the propensity score-matched pairs.FindingsWhile higher customer concentration, on average, leads to higher yield spreads and strict covenants, firms that have the US Government as a major customer pay lower yield spreads and have higher issue ratings. However, as a firm’s sales depend too heavily on the US Government customer channel, the bond issuance is likely to have lower issue ratings. The main findings also show that firms with government concentrations take advantage of political links, leading to lower yield spreads after two exogenous events.Originality/valueThe findings in this paper show the importance of a firm’s customer types in bond markets by emphasizing the positive impact of the US Government as the sales channel. Exogenous event studies based on the propensity-matched sample alleviate the endogenous concerns.

Government contracts and US bond yield spreads: A study on costs and benefits of materialized political connections

AbstractIn a 1991–2013 sample of bonds issued by US public firms, we find that the cost of debt (yield spread relative to comparable Treasuries) of suppliers to government agencies is contingent on the strategic importance of the supplier's industry. The yield spreads for strategically unimportant government suppliers are higher than for firms that are not government suppliers. If government contracts serve as tangible evidence of political connections, these higher yield spreads indicate that weaker corporate governance as a cost of political connections outweighs the benefits of said connections. For the subsample of government suppliers from strategically important industries, where the benefits of implicit bailout guarantees and revenue stability outweigh the corporate governance problems, the cost of debt is lower than for firms that are not government suppliers. The higher (lower) cost of debt for strategically unimportant (strategically important) suppliers is confined to contracting with the federal government. Our findings are robust to alternative variable and sample specifications, and to endogeneity concerns.

Oil price uncertainty and movements in the US government bond risk premia

In this paper, we analyze the predictability of the movements of bond premia of US Treasury due to oil price uncertainty over the monthly period 1953:06 to 2016:12. For our purpose, we use a higher order nonparametric causality-in-quantiles framework, which in turn, allows us to test for predictability over the entire conditional distribution of not only bond returns, but also its volatility, by controlling for misspecification due to uncaptured nonlinearity and structural breaks, which we show to exist in our data. We find that oil uncertainty not only predicts (increases) US bond returns, but also its volatility, with the effect on the latter being stronger. In addition, oil uncertainty tends to have a stronger impact on the shortest and longest maturities (2- and 5-year), and relatively weaker impact on bonds with medium-term (3- and 4-year) maturities. Our results are robust to alternative measures of oil market uncertainty and bond market volatility.

Is Fed an Elephant or a Bellwether? The Impacts of SMCCF on US Corporate Bond Market

We study the impacts of Secondary Market Corporate Credit Facilities (SMCCF) on US corporate bond market. Using foreign “Yankee” bonds as a control group that are ineligible for direct purchase of SMCCF, we find that SMCCF significantly reduces the yield spreads of US bonds. However, the impacts differ by bond ratings and remaining maturity with safer bonds (AA/A-rated) and short-term bonds (remaining maturity less than 5 years) benefiting the most from SMCCF. We find that neither liquidity conditions nor credit risk profiles can account for the widened yield spread difference between US bonds and their foreign “Yankee” counterparts. SMCCF improves liquidity for both US bonds and “Yankee” bonds. The CDS-bond basis of US bonds, nonetheless, increases relative to the “Yankee” bonds. Although SMCCF does not run through the bond market like an elephant and more resembles a bellwether driving bond investors, our results indicate that the distorted notion of credit risk due to its purchase pledge and the weakened information efficiency in the bond market can be concerning.